Why Advertising “Conflict-Free” Advice Could Violate The SEC’s Marketing Rule

RIAs' Obligation To Disclose Conflicts Of Interest

One of the cornerstone fiduciary obligations of financial advisors is to make full disclosure of any conflicts of interest that exist between themselves and their clients. The simple logic behind this rule is that, in order to make a fully informed decision about whether or not to engage an advisor's services, a prospective client needs to know whether there are any factors in the advisor's compensation or business model that might cause the advisor to be less than objective in the advice they give. And by requiring advisors to be transparent about those conflicts, the SEC and state regulators aim to give retail investors reasonable assurance that an advisor they hire won't have any hidden conflicts that could cause them to put their own financial interests ahead of the client's.

Notably, the SEC and state regulators don't necessarily require advisors to eliminate all potential conflicts of interest (with a few rare exceptions, such as sales contests or quotas, which were broadly banned for broker-dealer firms under the SEC's Regulation Best Interest rule). Rather, firms are expected to evaluate and disclose each of their potential conflicts and the extent to which they could influence an advisor's recommendations in deciding how to address them.

In cases where it's difficult or impossible for advisors to provide objective advice (e.g., when the advisor is compensated more for the firm's proprietary funds than for other products, or when their payout rate increases steeply after hitting specific sales targets), the SEC or state regulators might force them to change their compensation structure or business practices to eliminate the conflict. But much of the time, regulators are fine with letting firms simply disclose the conflicts (generally on their Form ADV Part 2A brochure that they provide to clients before their initial engagement and annually thereafter) and implement policies and procedures to supervise their employees, making sure that the conflicts don't get in the way of providing objective advice.

Conflicts That Advisors Must Disclose

There's a wide range of business practices that could create potential conflicts of interest for RIAs and their advisors. The most common conflicts arise when an advisory firm is dually registered as, or affiliated with, a broker-dealer firm or insurance agency. Conflicts also arise when advisors themselves – i.e., the Investment Adviser Representatives (IARs) of the advisory firm – are also broker-dealer registered representatives or insurance agents, since they may earn a commission from recommending certain products.

The IAR might sell products on behalf of the advisory firm itself (if it's a dually registered firm), a subsidiary or affiliate of the RIA, or an unaffiliated firm as an "outside business activity". But regardless of the IAR's ‘employer' when selling products on commission, that potential conflict needs to be disclosed by the firm that employs them for advisory services.

Even for firms that don't earn commissions, conflicts can (and in practice almost always do) pop up that merit disclosure on Form ADV Part 2A. These include (but are by no means limited to):

• Conflicts of interest around rollover advice, such as when advisors recommend that a client roll over funds from their employer's 401(k) plan into an IRA managed by the advisor. This increases the advisor's compensation if they're paid based on a percentage of Assets Under Management (AUM), which many firms have started to disclose on ADV Part 2A in light of the requirements of the Department of Labor's PTE 2020-02).
• Conflicts surrounding referral fees, where advisors may receive compensation for referring clients to account managers or tax, legal, or other service providers.
• Conflicts around common ownership between the advisory firm and other entities like insurance companies, accounting firms, banks, or broker-dealers. If the RIA is one branch of an overarching entity, there may still be an incentive to make ‘in-house' recommendations even if the RIA itself doesn't receive commissions or referral fees.
• Using paid lead generation services or other types of 'promoters' to refer clients to the advisor, which is more of a conflict for the promoter but still creates the incentive for one of the parties to put their own interests above the client's.
• Advisory firm employees being allowed to own and trade the same securities that are recommended to clients, which can theoretically lead to front-running and taking advantage of better prices than the client would receive.
• 'Soft dollar benefits' received by custodial platforms, where advisors receive services like investment research, practice management resources, technology, or other benefits for 'free' from the custodian. Which custodians typically offer in order to entice advisors to house client dollars on their platforms, from which the custodian can earn revenue via spreads on cash sweeps, payment for order flow, securities lending, and/or proprietary funds.

…all of which (and more) routinely appear in some combination on advisory firms' ADV filings.

Even Minor Conflicts Must Be Disclosed (Because They're Still Conflicts)

Clearly, some of the conflicts of interest between advisors and their clients are more severe than others, as they create more of a temptation for advisors to (consciously or unconsciously) prioritize their own or the firm's interests over their clients'.

On the more 'conflicted' end of the spectrum, there are practices that directly affect how the firm and its advisors are compensated. Commission-based compensation, AUM fees on rolled-over retirement accounts, and referral fees from managed accounts and other service providers all present strong incentives to make recommendations that produce the most financial benefit for the advisor rather than for the client, because making one recommendation versus another can literally determine how much revenue the advisor earns. Which makes these types of conflicts a frequent target of regulatory scrutiny to ensure that the firm has (and follows) policies, supervisory practices, and thorough documentation procedures to mitigate the effects of any direct compensation-related conflicts.

On the other end of the spectrum are conflicts that aren't tied so directly to advisors' compensation. For example, incentives like soft-dollar benefits, while presenting enough of a conflict to warrant a disclosure on an advisor's Form ADV Part 2A, in practice rarely influence an advisor's choice of custodian. This is largely because almost all custodians offer soft-dollar benefits in some form (e.g., Charles Schwab offers its iRebal software for 'free' to advisors on its platform, and Altruist makes its portfolio accounting and performance reporting software available for ‘free' for all brokerage accounts on its platform, charging $1/month for accounts at other custodians). Operationally, however, having a large and trustworthy custodian, with responsive customer support that can quickly help resolve client issues as they arise, is simply more valuable to an advisory firm than the comparatively marginal benefits that 'soft dollars' tend to provide.

But at the end of the day, no matter their scope or severity, all of these scenarios represent real conflicts of interest between financial advisors and their clients. Or at the very least, incentives that could influence an advisor's actions, and thus merit disclosure (e.g., very few advisors would actually "front-run" their clients' trades, but the mere possibility of doing so requires a disclosure in the eyes of many regulators).

Many RIAs' business practices encompass at least one of these conflicts of interest. In fact, given the sheer number of advisors who 1) charge AUM fees and give advice on rollovers, and 2) custody at a major platform like Schwab that provides soft-dollar benefits, it's rare to find an advisory firm that doesn't disclose at least those 2 potential conflicts. Which doesn't necessarily imply that the industry as a whole is overly conflicted or that all advisors put their own interests ahead of their clients. Rather, it speaks to how, in an industry with a wide range of service and compensation models – and with a vast adjacent sector of financial product and service providers competing for the assets of advisory clients – conflicts of interest are almost inevitable no matter which business model the advisory firm chooses.

This also happens to be the point of view of regulators at the SEC, who say as much in their Staff Bulletin on Standards of Conduct for Broker-Dealers and Investment Advisers Conflicts of Interest:

[Q:] Do all broker-dealers and investment advisers have conflicts of interest?

[A:] Yes. All broker-dealers, investment advisers, and financial professionals have at least some conflicts of interest with their retail investors.

For advisory firms, then, it's not necessarily a matter of whether there are any conflicts of interest, period, that need to be disclosed to clients; it's more about how much of a threat the conflicts that do exist pose to advisors' objectivity, and what the firm does to structure its processes and supervise its advisors to ensure they're actually serving their clients' best interests.

Or, put more succinctly, there's no such thing as conflict-free advice – what really matters is how advisors minimize their conflicts and how they disclose and manage the ones that remain.

The SEC's Enforcement Actions Against Firms Advertising "Conflict-Free Advice"

Over the last 30 years, the financial advice industry has broadly shifted from a primarily sales-based business model (as in the early days when almost all advisors were compensated on commission for selling insurance, mutual funds, and other financial products) to one that is primarily advice-based (as in firms that are mostly or solely compensated by their clients for the advice they give, rather than by a financial services firm for the products they sell). Much of the shift was driven by increasing awareness in the media and the general public of the conflicts of interest inherent in the sales-based approach, and of the gaps in the standards of conduct between broker-dealers (who needed only to ensure that the products they sold were 'suitable' for the customers they dealt with) and registered investment advisers (who are held to a stricter fiduciary standard).

As the shift was occurring, using the term "fiduciary" became a point of distinction for firms following the advice model to differentiate themselves from sales-based advisors who weren't always held to a fiduciary standard. The caveat, however, was that firms often struggled to convey the meaning of being a fiduciary in a way that actually resonated with prospective clients. Since the term "fiduciary" hasn't been broadly understood by the general public, firms needed a way to succinctly communicate that they were held to a legal standard requiring them to act in their clients' best interests and, therefore, worthy of clients' trust in helping them make financial decisions and managing their assets.

This need to communicate the 'fiduciary' concept led to the proliferation of other descriptors on advisory firms' websites and marketing materials, like "fee-only" (denoting firms that only received compensation in the form of advisory fees from their clients, not commissions or sales-based compensation), "'real' financial advice" (indicating firms that put emphasis on the advice itself, rather than the investment product or portfolio that the advice leads to), and "conflict-free advice" (to differentiate from the well-publicized conflicts of interest inherent when an advisor is compensated on commission). All implying, either directly or indirectly, that the advisory firm doing the advertising was different from the "traditional" advisor archetype who earned their income on the more conflicted commission-based model.

But, as noted earlier, given the sheer scope of conflicts routinely disclosed by RIAs across all business models, the fact that an advisor may be less conflicted when they aren't compensated on commission doesn't mean that they have no conflicts of interest. Which poses a problem specifically for firms that use terms like "conflict-free" to describe their advice, since, in almost all cases, they actually do have conflicts that they disclose on their Form ADV Part 2A.

Details Of The SEC's "Conflict-Free Advice" Cases

The SEC recently brought the problem with advertising "conflict-free" advice into sharp focus when it announced that it had settled charges against several RIAs for violating the commission's Marketing Rule. Notably, the SEC charged 4 different firms that, in the SEC's words, "disseminated advertisements that claimed to provide conflict-free advisory services, which the firms were not able to substantiate". These firms paid fines ranging from $70,000 up to $325,000.

Under the SEC's Marketing Rule, advisory firms are prohibited from including any "material statement of fact that the adviser does not have a reasonable basis for believing it will be able to substantiate" in their advertising materials. In each of the 4 enforcement actions, the SEC found that the firms had put statements on their websites implying that the firms had no conflicts of interest, even though each firm had also disclosed one or more conflicts of interest in their Form ADV Part 2A brochures. In the SEC's view, it was clear that the firms couldn't substantiate their claims to provide conflict-free advice, which put them in violation of the Marketing Rule and led to the charges and fines.

Notably, the conflicts of interest disclosed by the firms themselves vary widely in scope and just serve to highlight the range of potential conflicts of interest that still permeate the advisory industry, even amid the larger shift to the fiduciary model.

For example, one of the firms fined by the SEC disclosed that, while the RIA itself wasn't registered as a broker-dealer, some of its advisors were registered representatives of a different broker-dealer firm that was affiliated with the RIA through common ownership. Similarly, in another case, some of the firm's advisors acted as registered representatives and insurance agents for other non-affiliated firms as part of their "outside business activities".

In both cases, even though the RIA firms themselves could technically claim to be compensated only in the form of advisory fees, their advisors were still compensated, at least in part, on a commission basis. Which obviously introduces a conflict of interest into the advice given by the firm's advisors, since their own income is directly affected by the recommendations they make. Meaning that the firms couldn't legitimately claim to offer "conflict-free" advice despite being fee-only in name, since the actual advice given by their advisors was conflicted by the advisors' own product-based compensation entanglements – which is ironically the exact same type of compensation-based conflict that other firms try to distinguish themselves from when they advertise as "conflict-free" in the first place!

But even when the firms that advertised themselves as "conflict-free" didn't have conflicts caused by commission-based compensation, they disclosed other types of real or potential conflicts of interest that clashed with their websites' claims to provide conflict-free advice. For example:

• 3 of the 4 firms' ADV Part 2As included disclosures around rollover advice and how a recommendation to roll funds over from a client's 401(k) plan into an IRA could increase the advisor's compensation;
• 3 firms disclosed that they receive soft-dollar benefits from their custodial platforms;
• 2 firms disclosed that they pay promoters to refer clients to the advisor;
• 2 firms disclosed that their employees are allowed to trade in the same securities as clients; and
• 2 firms disclosed that they may refer clients to third-party subadvisors who may, in turn, compensate the advisor.

All this is not to pick on the specific advisory firms cited by the SEC for violating the Marketing Rule since the conflicts listed above are by no means unique to those firms (and the very fact that they had disclosed all those conflicts means that those firms were at least attuned to the fact that they had conflicts of interest and were compliant in disclosing them in their regulatory filings). Rather, it's to point out that having conflicts of interest doesn't just mean taking commissions, but encompasses the whole scope of possible conflicts, from relatively minor ones to major compensation-based conflicts.

But the key takeaway for advisors is that, when an advisory firm claims on its website that it gives "conflict-free advice", the SEC and other regulators will take that claim literally – meaning that if there are any conflicts disclosed in the advisor's Form ADV Part 2A, no matter how big or small, then regulators can argue that the advisor can't substantiate the claim to being "conflict-free", and are therefore in violation of the Marketing Rule.

Finding A Better (And More Compliant) Marketing Descriptor Than "Conflict-Free"

It's obviously good for advisors to minimize their conflicts of interest wherever possible. From a fiduciary perspective, it's easier and more straightforward to give advice in a client's best interest when there are minimal conflicts that could sway an advisor's judgment. And from a marketing perspective, fewer conflicts mean fewer disclosures to prospective clients who are increasingly aware of how such conflicts can affect advisors' objectivity and effectiveness.

But, as noted earlier, it's almost impossible for advisory firms to eliminate every potential conflict of interest. Which means that it's rarely (if ever) advisable for firms to advertise themselves as "conflict-free".

Avoid The "Conflict-Free" Label

As the SEC's recent enforcement actions show, it's never a good idea to use "conflict-free" as a descriptor if there are any conflicts of interest disclosed on the firm's Form ADV Part 2A. And since failing to disclose the conflicts would violate the advisor's disclosure obligations under SEC and state law, there's no option for advisory firms that do have conflicts disclosed in their regulatory filings other than avoiding describing their services as "conflict-free".

Ironically, the fact that RIAs can't describe themselves as "conflict-free" because they so often do have conflicts to disclose is at least in part due to the SEC's own actions, which have long permitted many forms of conflicts of interest – unofficially for years, but more explicitly since the adoption of the Regulation Best Interest rule. Even for advisors held to a fiduciary standard, a firm is only required to eliminate conflicts if they can't be adequately disclosed to clients. Meaning that as long as conflicts are disclosed, they're likely to be tolerated by regulators.

If the SEC had instead taken the opposite approach – requiring advisors to eliminate their conflicts of interest and only disclose when the conflicts can't feasibly be avoided – there might be fewer conflicts inherent in the advisory industry to begin with. As a result, fewer advisors would feel the need to differentiate themselves from more conflicted (but still compliant) RIAs by using terms like "conflict-free" to describe themselves.

But as long as the SEC's fiduciary standard is what it is, there will still be RIAs that can (accurately) describe themselves as operating under a fiduciary (or "best interests" standard while still receiving commissions and other conflicted compensation. Which means that there will continue to be firms that voluntarily hold themselves to a stricter standard, minimizing or eliminating conflicts of interest wherever possible, and seeking ways to differentiate themselves beyond their being held to a fiduciary standard that applies all RIAs, no matter how conflicted.

Using "Commission-Free" As A Possible Alternative

But if RIA's can't claim to be "conflict-free" – since almost all advisors will have some conflicts to disclose, no matter how seemingly minor – then what can they say to make that distinction?

One option would be to simply say what most firms seem to mean when they say "conflict-free", which is "commission-free". For example, "Our firm does not receive any commissions or sales-based compensation that could compromise our objectivity in providing advice to our clients". Although obviously, the firm could only say this if it doesn't actually receive commissions.

The caveat is that "commission-free", when used as a stand-in for "conflict-free", opens up some loopholes for firms to use the label that may ultimately create even more confusion among consumers about how an advisor is compensated. For example, even though some firms may not take commissions themselves, they may have affiliates who do (e.g., an insurance company owned by the same parent company as the RIA or operating as a subsidiary). Additionally, advisors may be independently registered as insurance agents, and while they may be technically "commission-free" when acting on behalf of the RIA firm, they may still receive commissions the rest of the time, creating confusion for clients about which 'version' of the advisor they're working with. Just as some of the firms in the SEC cases above might claimed to offer "conflict-free" advice even though their advisors – not the firm – accept commissions, other firms could take advantage of the same discrepancy by describing themselves as "commission-free" when it isn't the firm itself that receives commissions (even though its advisors still do).

Highlight Transparency And Conflict Management

Rather than marketing themselves as "commission-free", another approach for firms is to be more transparent about their existing conflicts of interest. Rather than downplaying the existence of any conflicts, firms can describe what they do to manage and minimize their effects on the advice that the firm's advisors give. Notably, advisors are already required to do this in their Form ADV Part 2A brochures, so it could simply be a matter of elevating that language to a page or blog post on the advisor's website in order to enhance its visibility to website visitors who don't take the step to click through (or fully read through) the ADV brochure.

Rather than emphasizing other business models' conflicts while downplaying one's own (even though the contradictory evidence may be there for everyone who clicks through to the ADV Part 2A), advisors may be able to build up more trust through transparency about their own potential conflicts – which, if the advisor has genuinely tried to minimize their own conflicts, might be so minor as to highlight how comparatively unconflicted the advisor really is.

Ultimately, advisory firms aren't required to highlight their own level of conflict (beyond what they're required to disclose in their ADV brochure). They're free to choose which aspects of their business to focus on in their advertising materials, so long as it stays within the bounds of the SEC's Marketing Rule or equivalent state laws. The reason that firms decide to use language like "conflict-free" is to signal that – unlike some other firms out there – their firm can be trusted to always keep the client's best interests at heart (never mind that they're already required to do so by the fiduciary obligation that covers all RIAs).

The problem with this approach is that for a prospective client who's looking for a financial advisor and doesn't already have conflict-of-interest issues top of mind, merely introducing the idea of conflicts – even if just to state there aren't any conflicts of interest that the prospect should worry about – can raise new concerns. This can be especially true when the client starts to read about the conflicts that the advisor does have and starts to question why the advisor found it necessary to downplay those conflicts rather than transparently explaining the conflicts and the steps the advisor takes to address them. At that point, the client's focus is on how the advisors' conflicts compare with other advisors the client has evaluated, and how that reflects on the advisor's trustworthiness – instead of focusing on the advisor's expertise and ability to solve clients' financial problems!

Shifting The Focus To The Advisor's Value

In other words, the problem with describing advice in terms of its relative level of conflict – whether that's using "conflict-free" or another descriptor intended to show how Advisor X is more aligned with its clients' interests than Advisor Y – is that not only does it have a lot of downsides (since there's now evidence that the SEC or other regulators could question the advisor's ability to substantiate that claim), but that it also doesn't really have that much upside in terms of actually reassuring clients that the advisor will do good work for them.

Instead, it might be better simply to focus on the value that the advisor does bring – e.g., the advisor's expertise in some niche area, their quality of client experience, or the way their values align with the clients' – rather than putting the spotlight on conflicts of interest. Although it may be tempting to focus on conflicts of interest to reassure prospective clients given the amount of media attention that's often directed to the subject, that conversation can – and from a marketing and sales perspective, probably should – come after the advisor has demonstrated their value in a more positive way.

The bottom line, however, is that whatever words an advisor uses to describe themselves on their website, social media, or other advertising materials should align with how they actually operate in practice. This is important not only from a regulatory and compliance perspective – because as the SEC's recent cases have proven, it's extremely easy to search a firm's Form ADV Part 2A for "conflict of interest" to find discrepancies in the firm's claim to be conflict-free – but also from the standpoint of building trust with prospective clients. After all, it's better to be transparent about the advisor's conflicts of interest than it is to use a label like "conflict-free", which may open the door to more questions about what kinds of conflicts the advisor actually has!